Macro (Re)view (13/12) | Global risks ease (for now)

In a key week for offshore risk events, markets gained a rare moment of clarity as some of the uncertainty that has persisted throughout 2019 appeared to be clearing, at least for the time being. Some 9 weeks after the US and China agreed to the outline of the phase one trade agreement, delegates from both sides formalised the text details, though it is yet to be signed by Presidents Trump and Xi. Of most immediate impact, this week's progress ensured that a planned US-levied tariff of 15% on a $160bn tranche of consumer-related imports from China set to come into effect on Sunday (15/12) will be averted, while China has cancelled retaliatory tariffs, which included a 25% import tax on US autos, due to start on the same day. 

In addition, the US has agreed to a partial rollback of the 15% tariff on a separate $120bn tranche of Chinese goods that commenced on September 1, which falls to 7.5% when the agreement is signed, though the 25% tariff on a larger $250bn list of mainly industrial imports is set to remain unchanged. Meanwhile, according to the USTR, China has agreed to undertake "substantial additional purchases of US goods and services in the coming years". A fact sheet compiled by the USTR (see here) outlined that this commitment is due to see China boost its import of US goods (including agricultural products) over the next 2 years so that the total value exceeds the level from 2017 by at least $200 billion, thus narrowing the US's trade deficit with China. Additionally, concessions have been granted by China relating to intellectual property commitments, forced technology transfers, financial services and foreign exchange devaluations. The final aspect of the phase one agreement is a dispute resolution mechanism, which opens the door for future tariffs or other measures to be implemented in the event of non-compliance. 

Over in the UK, PM Boris Johnson secured a resounding victory in Thursday's general election that resulted in the Conservatives gaining an 80-seat majority in the Commons, the largest for the Tories since 1987. With the path now clear for an orderly Brexit to occur on January 31, market attention now turns to the nature of the arrangement the PM will negotiate with the EU during this transitory period, particularly in regards to matters of trade and migration. For its part, EU Council President Charles Michel said that negotiations should be conducted on the basis of "maintaining close co-operation" with the UK. But, for now, after more than 3 years of deep uncertainty, the premise of a stable government should offer much-needed support to a UK economy that has essentially stalled.

The other main focus this week was on the latest policy meetings from the Federal Reserve (Fed) and the European Central Bank (ECB). In the US, the Fed's policy-setting Committee paused their easing cycle leaving its benchmark interest rate unchanged at 1.5-1.75%, as expected. Following a total of 75 basis points of cuts being delivered at their three previous meetings as "insurance" from a weakening global economy and trade uncertainty, Committee Chair Jerome Powell described the current rates setting as "well positioned" to support the constructive outlook conveyed in the updated summary of economic projections, in which its GDP growth forecasts were unchanged from 3 months ago at 2.2% in 2019, 2.0% in 2020, 1.9% in 2021 and 1.8% in 2022. The unemployment rate is now seen a touch lower in 2019 at 3.6% and was then trimmed by 0.2ppt in each of 2020 (3.5%), 2021 (3.6%) and 2022 (3.7%), however in the post-meeting press conference Chair Powell was reluctant to classify the labour market as "tight" given the current pace of wages growth (3.1%Y/Y) and instead described it as "strong". Consistent with that assessment, the inflation outlook remained mostly intact and is not expected to return to the target until 2021. Indicating the Committee is now in wait-and-see mode, Chair Powell outlined that the current monetary policy stance "would likely remain appropriate" unless the data flow was to cause a "material reassessment of our outlook". As such, the revised 'dot plot', which contains individual members' projections for their expected path for rates, implied the Committee would be on hold for an extended period until 2021 where the median forecast was for one rate increase.

The ECB also finds itself in wait-and-see mode after recently implementing a broad-based package of stimulus measures and thus the Governing Council held its policy stance unchanged at this week's meeting. The updated ECB staff macroeconomic projections contained only minor alterations compared with September's forecasts. GDP growth for 2019 was lifted from 1.1% to 1.2% but was trimmed from 1.2% to 1.1% for 2020 before rising to 1.4% in 2021 and 2022. The inflation forecast was left at 1.2% in 2019, then slightly upgraded to 1.1% (from 1.0%) in 2020, while in 2021 it was lowered from 1.5% to 1.4%. New ECB President Christine Lagarde in the post-meeting press conference outlined that while the risks to the growth outlook remained "tilted to the downside" some of the uncertainties that have weighed on activity in the bloc, most notably in the manufacturing sector, relating to trade and geopolitical tensions had become "somewhat less pronounced". Though the data flow was still regarded as weak overall, it was noted that there had been "some stabilisation in the slowdown of economic growth in the euro area". 

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Turning to the domestic perspective, the latest consumer and business surveys were in line with last week's subdued update on the Australian economy in Q3's National Accounts (see here). Concerns around the economic outlook and a general reticence to spend continue to be prevailing themes for households as the Westpac-Melbourne Institute's Index of Consumer Sentiment fell by 1.9% in December to a reading of 95.1, with the headline index remaining inside pessimistic territory for a 4th consecutive month (see chart of the week, below). The deterioration in sentiment over the second half of 2019 indicates a tepid response from consumers to recent stimulus from RBA rate cuts and increases to the Federal government's low and middle income tax offset.

Chart of the week

The combined impact of this stimulus was a 2.1% surge in household disposable income growth in Q3, though last week's National Accounts indicated this windfall was to a large extent saved as household consumption growth edged up by just 0.1% in the quarter and annual growth slowed to a post-GFC low of 1.2%. Westpac's Chief Economist Bill Evans reports that since the RBA recommenced its easing cycle in June, consumer sentiment has declined by 6.1% and in this latest update views around the economic outlook slipped on both a 12 -month (-1.1%) and 5-year (-2.4%) outlook to partially reverse increases in November. Through the year, consumers' forward-looking assessment of economic conditions has deteriorated sharply; 'next 12 months' -14.2% and 'next 5 years' -11.0% and as a result of this heightened caution, spending has clearly been reined in. Household debt is also weighing as evidenced by a deterioration in views towards family finances, with the 'vs a year ago' sub-index down by 3.6% in December (-9.5%yr) and the 'next 12 months' sub-index easing by 0.5% in the month (-7.0%yr). Accordingly, 64% of consumers nominated deposits, superannuation or paying down debt as the 'wisest place for savings', to be up from 62% in September. Undoubtedly, the stimulus from RBA rate cuts has helped drive a recovery in the established housing market, with capital city prices posting their first quarterly rise in nearly 2 years in Q3 (see here), while more timely data from CoreLogic has shown these price gains have extended into the current quarter. Consumers expect this trend will continue, with the Westpac-Melbourne Institute's House Price Expectations Index rising by a further 3.2% in December to be up by 40.1% over the year. As such, the 'time to buy a dwelling' index contracted by a sharp 5.6% in December and is up only modestly (1.8%) from a year earlier.  

In the NAB's Business Survey for November, confidence slid from a reading of +2 to 0 and conditions held steady at +4, with both indexes remaining at below-average levels. The sub-components within the conditions index were mixed, with trading down from +7 to +6 and profitability up from 0 to +3 (both are at below-average levels), while an unchanged reading for employment at +4 saw it remaining above average to be indicative of jobs growth averaging around 18k per month over the next 6 months according to NAB Economics. However, the leading indicators pointed to ongoing caution around the outlook for business investment, with forward orders falling from +3 to -2 and capacity utilisation a touch softer at an around-average 81.8% reading.

Q3 signals a turnaround for Australian house prices

The near two-year-long downturn in Australian house prices came to an end in the September quarter according to the ABS's Residential Property Price Indexes data, as the combined impacts of RBA rate cuts, an easing in macroprudential policy and the passage of May's federal election played through the established housing market. The weighted-average of capital city prices lifted by 2.4% in the September quarter — its first quarterly rise since Q4 2017 — as the decline in through the year terms moderated to its slowest pace in 12 months at -3.7%. From peak to trough, on average, capital city house prices on a national basis fell by 8.0% between mid-2017 and mid-2019. 

The Sydney and Melbourne markets have led the recovery, each rising by 3.6% in Q3 supported by both the house and unit segments. Hobart prices added a further 1.3% in the quarter, while the Brisbane market saw prices lift (0.7%) for the first time in a year. Elsewhere, prices continued to fall and as a result the annual declines in Adelaide (-1.0%), Perth (-4.6%), Darwin (-5.4%) and Canberra (-1.4%) steepened a little.
    

The granular breakdown of price changes across capital cities and segments for Q3 and over the past year is shown in the table, below.

With prices rising in the quarter, the total value of Australia's residential dwelling stock increased by 2.8% in Q3 to $6.869tn, as annual growth (0.1%) turned positive for the first time in a year. 

  

The ABS's series lags the more timely monthly updates on Australian property prices compiled by CoreLogic. Last week, CoreLogic reported that capital city prices increased by 2.0% in November, which followed a 1.4% rise in October, to be up by 0.4% over the year.  

Macro (Re)view (6/12) | Australian Q3 GDP subdued despite stimulus

The Australian economy remains subdued with this week's National Accounts for the September quarter reporting that GDP growth lifted by a softer-than-expected 0.4% in Q3 as the annual pace ticked up from 1.6% to 1.7%. At this pace, activity continues to be around 1ppt lower than than the nation's trend rate of growth of around 2.75%. Weakness in the private sector continued to weigh on domestic demand as households were disappointingly absent despite receiving a sizeable income boost from recent RBA rate cuts and fiscal stimulus through tax relief for low-and middle-income earners, though ongoing strength in public demand and a robust export sector were key supports (see our full review here).

Household consumption growth lifted by just 0.1% in Q3 — its softest quarterly outcome since Q4 2008 — while in annual terms, the momentum slowed from 1.4% to 1.2% to be at its weakest pace in the post-GFC period. In context, household consumption growth was running at a 2.6% annual pace a year ago. Factors that have driven this slowdown include subdued confidence due to concerns over the economic outlook, uncertainty in the lead-up to May's federal election and from developments offshore as global growth has slowed, a correction in house prices and low wages growth. In the quarter, the benefits from the RBA's rate cuts in June and July and the Federal government's tax cuts began to flow. As a result, in nominal terms, tax payments fell by 6.8% and interest payments were down by 2.5%. Adjusting for inflation, real household disposable incomes accelerated by 2.1% in Q3 to an annual pace of 3.1%, which is a 5-year high. However, this income boost was largely saved by consumers as the household saving ratio surged up by 2.1ppts to 4.8% to a 2½-year high and helps to explain the soft outcome for household consumption in Q3 (see chart of the week, below) 

Chart of the week 

At this week's RBA policy meeting, the Board held the cash rate steady at 0.75% but remains prepared to ease further should its constructive outlook deteriorate (see here). The Bank's forecast is for GDP growth to lift to 2.3% by year's end and then rise to around a 3% annual pace in 2021. The decision statement from Governor Philip Lowe outlined that the transmission from its rate cuts to the real economy will work with "long and variable lags", with the Bank expecting that, in time, households will lift spending in response to the income boost and also due to a wealth effect accruing from an improving established housing market. Data this week from CoreLogic showed national property prices have now lifted for 5 consecutive months after a 1.7% rise in November as annual growth (0.1%) turned positive for the first time since April 2018. However, the early indications are that households' reticence to spend was evident at the start of Q4 as retail sales stalled in October and annual growth slowed to a 2-year low of 2.1% (see here). It is possible that households decided to wait for Black Friday sales promotions and the Christmas period to come around before making use of the windfall from the recent stimulus measures, so the retail sales data in the months ahead will be of importance.

The National Accounts also continued to highlight that residential construction and business investment remain areas of concern in the domestic economy. The downturn in the residential construction cycle intensified in Q3 as activity contracted by 1.7% to be down by 9.6% over the past year, which is its sharpest rate of decline in 7 years. Activity in new home building is even weaker at -11.0% through the year and is contracting at its fastest rate in 18 years. With dwelling approvals showing renewed weakness in October with an 8.1% fall (-23.6%yr), the downturn in activity is likely to persist throughout 2020 (see here). Private sector business investment fell by 2.0% in Q3 and -1.7% for the year, with the annual pace remaining in contraction for the 5th straight quarter. Mining investment took a final step lower as major projects reached completion to be down by 7.8% in the quarter and -11.2% for the year, though the outlook is for a rise of around 16% in 2019/20, based on the recent ABS Capital Expenditure Survey. Non-mining investment was up by 1.2% in Q3 and 2.2% through the year, but as covered in last week's review, plans for 2019/20 are looking less constructive, with uncertainty from offshore and weak domestic demand conditions headwinds for the investment climate. 

In contrast to weak private sector demand, robust growth in public demand remained in train over Q3 with a 1.5% rise to be up by 4.9% in annual terms. This has been supported by spending associated with public healthcare initiatives and investment in infrastructure in response to strong population growth. The other leading contributor to activity over the past year has been net exports (1.1ppts). Export volumes were up by 0.7% in Q3 to 3.3% in annual terms, driven by a ramp-up in production from the resources sector and strong demand for services associated with tourism and education. Meanwhile, weakness in exports (-0.2%q/q, -1.5%yr) reflects declining investment in capital goods and the impact of a lower Australian dollar. This profile ensured the current account remained in surplus for the second consecutive quarter in Q3 (see here), though the trade surplus subsequently pulled back by $2.3bn in October to $4.5bn as iron ore prices corrected from their mid-year peaks (see here). 

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In offshore developments this week, conflicting trade headlines saw markets swing between gains and losses. To start the week, US President Trump announced he would restore steel and aluminum import tariffs on Argentina and Brazil on the basis that these two countries had been "presiding over a massive devaluation of their currencies, which is not good for our farmers". Later on in the week, President Trump said that he was in no haste to complete the phase one trade deal with China, though the planned 15% tariff on a $160bn tranche of Chinese imports would go ahead on December 15 if the status quo remained. The latest US activity data produced contrasting results this week, with manufacturing conditions according to the ISM survey remaining in contraction after falling from 48.3 to 48.1 in November as the new orders and employment sub-indexes declined, though in the more broadly-based Markit Purchasing Managers' Index (PMI) the sector is in expansion as conditions improved over the month from 51.3 to 52.6 on gains in new orders and employment. Similarly, the ISM non-manufacturing survey indicated conditions in the services sector slowed from 54.7 to 53.9 driven by a sharp fall in business activity, while Markit's services PMI firmed from 50.6 to 51.6 on renewed strength in new business after a fall in the previous month. The overall state of conditions was perhaps best summarised by Markit's Composite PMI, which firmed from 50.9 to 52.0 to indicate private sector business activity across the US was increasing modestly at a below-average pace. 

The consumer continues to hold the key to growth in the US and that is not surprising given the strength of the labour market. On Friday, the latest employment data for November was much stronger than expected; even allowing for 48k GM workers returning from strike, as non-farm payrolls added 266k jobs in the month compared to the 180k expected. An easing in the participation rate to 63.2% enabled the unemployment rate to reverse its increase in October and return to its equal-lowest in 50 years at 3.5%. Wages growth was solid at 3.1% over the year but is relatively well contained considering how tight the labour market is. As a result, consumers are feeling more optimistic as sentiment according to the University of Michigan's index lifted by a robust 2.5% in December to a 7-month high at 99.2 driven by a more upbeat assessment of current economic conditions. 

Turning to Europe, GDP growth in the bloc in the September quarter was confirmed at 0.2% and the annual pace held steady at 1.2%. Overall, domestic demand remains supportive of activity, but weakness in the global economy and uncertainty associated with trade and geopolitical tensions has weighed heavily on net exports and inventories. So far in Q4, activity remains soft according to Markit's composite PMI, which was unchanged at 50.6 in November and indicated the economy was close to stalling. The weakness remains centred on the manufacturing sector, which is currently mired in its deepest downturn in 7 years despite an improvement in Markit's manufacturing PMI from 45.9 to 46.9 in November.  Conditions in Germany are of key concern, with industrial output contracting by its fastest pace in a decade at -5.3% over the year to October. Meanwhile, the more domestically-focused services sector remains in an expansionary phase but activity is slowing as Markit's services PMI fell from a reading of 52.2 to 51.9 in November. 

In review: Australian Q3 GDP growth 1.7%; households languishing

Momentum in the Australian economy remains subdued, with real GDP growth on a seasonally adjusted basis rising by 0.4% in the September quarter to disappoint the consensus expectation for a 0.5% increase. Annual growth moved a touch higher from an upwardly revised pace of 1.6% to 1.7% but remains well below the nation's trend rate of growth of around 2.75%. 

In the September quarter, the headwinds from a weaker global economy persisted as a result of trade and geopolitical uncertainties and structural weaknesses associated with low productivity growth and aging demographics, while domestically household consumption growth slowed further, the downturn in the residential construction cycle intensified and the final phase of the unwind in the mining sector weighed on business investment. With the domestic economy operating well below capacity and inflation low, the Reserve Bank of Australia (RBA) followed up its rate cut late in Q2 with an additional 25 basis point reduction to the cash rate in July to a then-record low of 1.0%. Fiscal stimulus from the Federal government in the form of tax relief directed towards low-and middle-income earners also came online during the quarter. The combined impact generated a sizeable boost to household disposable income, however; subdued confidence prompted by concerns around the economic outlook meant that the focus was on saving and paying down debt rather than spending.

The composition of growth remains imbalanced between robust public demand, which lifted by a further 1.5% in Q3 to be up by 4.9% over the year in response to healthcare spending and infrastructure investment, and weakness in private sector demand that contracted by 0.2% in the quarter and by -0.4% through the year to be at its weakest pace since the GFC, weighed by slowing household spending and weakness in residential construction and business investment.     

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GDP — Q3 | Expenditure: GDP (E) 0.5%q/q, 1.7%Y/Y

Household consumption (0.1%q/q, 1.2%Y/Y) — Growth in household consumption was 0.1% in Q3 — its softest quarterly outcome since Q4 2008 — while the annual pace eased from 1.4% to 1.2% to be at it lowest in the post-GFC period.

The detailed breakdown showed spending continues to be led by non-discretionary areas of demand (0.4%q/q, 2.0%Y/Y), highlighted by strong quarterly rises from health (0.9%) and rents (0.6%). There was further weakness from the discretionary areas (-0.3%q/q, 0.0%Y/Y), driven by sizeable declines from vehicles (-1.0%) and hotels, cafes and restaurants (-0.9%) in Q3. 

Household disposable income growth was up by a sharp 2.5% in Q3 — its strongest quarterly rise since Q4 2010 — with annual growth accelerating from 2.7% to a 5-year high at 5.1%. In real terms, disposable income increased by 2.1% in the quarter and by 3.1% over the year. These strong outturns were the result of stimulus from two RBA rate cuts in June and July, which lowered total interest payments by 2.5% in Q3, and tax relief from the Federal government that was directed at low-and middle-income earners and resulted in a 6.8% fall in income tax payments in the quarter. At the same time, however, the household saving ratio surged by 2.1ppts to a 2½-year high at 4.8%. Thus, it is clear consumers used the windfall to bolster saving rather than lift spending, which is a likely response to subdued confidence and concerns over the economic outlook. 

Dwelling investment (-1.7%q/q, -9.6%Y/Y) — For the fourth consecutive quarter, residential construction activity declined, falling by 1.7% in Q3 as the annual contraction steepened from -7.8% to -9.6% to be in its deepest downturn in 7 years. New dwelling construction is weaker still after falling by a further 2.8% in Q3 to be down by 11.0% over the year, with activity contracting at its fastest pace in 18 years. Alterations lifted by 0.6% in the quarter, though the annual decline lifted from -4.1% to -7.1%. The intensification of the downturn in the residential construction cycle reflects an ongoing deterioration in dwelling approvals, which have fallen by around 20% over the past year.   

Business investment (-2.0%q/q, -1.7%Y/Y) — Weakness persists in business investment, which, on net, declined by 2.0% in Q3 to be down by 1.7% through the year reflecting headwinds from an uncertain global economic outlook and weak domestic demand conditions. The unwind in the mining sector associated with the completion of major LNG projects took its final leg lower with a 7.8% contraction in the quarter for an annual fall of 11.2%. Accordingly, engineering (infrastructure) investment was down by 5.9% in Q3 and 12.2% lower over the year. Based on the ABS's recent Capital Expenditure survey, investment plans for 2019/20 pointed to a 16% rise from the mining sector that would bring an end to 6 consecutive years of decline. Non-mining investment lifted modestly by 1.2% in Q3 and by 2.2% year-on-year around patchy detail. Non-dwelling construction is a point of strength (3.0%q/q, 4.2%) following an upswing in approvals, though equipment investment was down by a sharp 4.5% in the quarter to be 2.2% lower over the year. Meanwhile, intellectual property investment lifted by a further 1.7% in Q3 to a robust 7.1% annual pace, while cultivated biological resources posted a 0.9% rise in the quarter but remain weak over the year at -5.9% in response to drought conditions.

          

Public demand (1.5%q/q, 4.9%Y/Y) — Robust public demand continued in Q3 and remained the leading contributor to activity over the past year. Supported by public health initiatives, consumption spending lifted by a further 0.9% in the quarter to be up by 6.0% in annual terms. Meanwhile, after a recent period of softness, strength appeared to be returning to public investment with a 3.8% rise in Q3 with further support likely from an elevated pipeline of infrastructure projects to work through.

  

Net exports (0.2ppt in Q3, 1.1ppt yr) — Net exports made a more modest contribution to activity this quarter at 0.2ppt after a 0.6ppt boost in Q2. Over the year, net exports have been a key support for the economy during a time of weak domestic demand adding 1.1ppt to headline GDP growth. Export volumes were up by 0.7% in Q3 and 3.3% over the year, driven by a ramp-up in LNG production and strength in services associated with education and tourism, though rural exports have contracted sharply (-10.5%) due to the drought. Import volumes fell for the fifth straight quarter with a 0.2% fall in Q3 to be down by 1.5% over the year, which is broadly reflective of soft consumer and business spending and a lower Australian dollar.     

Inventories (0.1ppt in Q3, -0.3ppt yr) — Inventories added slighty to activity in Q3 following a sharp 0.4ppt contraction in Q2, however they have weighed over the year with the weakness centring on the retail sector consistent with weak consumer demand.  

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GDP — Q3 | Incomes: GDP (I) 0.4%q/q, 1.6%Y/Y

The real GDP income estimate posted a 0.4% rise in the September quarter, which was below the expenditure estimate but in line with the production estimate, while the annual pace ticked up from 1.5% to 1.6%. 

Australian GDP in nominal terms increased by 1.1% in Q3 that kept the annual pace steady at 5.5%. Its most recent trough came in Q4 2017 where annual growth was at 3.9%. Solid growth in each of the past 7 quarters has been driven by strength in commodities prices, though the impact was modest in Q3. The nation's terms of trade lifted by 0.4% in Q3 — its softest quarterly outcome since Q2 2018 — while annual growth eased slightly from 8.1% to 7.8%. 

Private sector company profits (excluding financial corporations) were up by 2.0% in Q3, though annual growth slowed from 14.2% to 13.2%. This strength has mainly centred on mining companies due to the tailwind from elevated commodities prices against a subdued picture from the non-mining sector. Financial corporations' profits increased by 0.5% in the quarter — its softest rise since Q4 2017 — as growth over the year slowed from 5.5% to 4.7%. 

Wages and salaries as measured by the Compensation of Employees figure increased by 1.1% in Q3, with annual growth down a fraction from 5.0% to 4.9%. The nation's wages bill has been trending higher over the past couple of years reflecting robust employment growth.

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GDP — Q3 | Production: GDP (P) 0.4%q/q, 1.9%Y/Y

The production estimate for GDP in Q3 was 0.4%; in line with the income estimate but softer than the expenditure outcome, while annual growth firmed from its decade low of 1.6% in Q2 to 1.9%.

Output in Q3 was weighed by; agriculture (-2.1%), other services (-1.7%), wholesale trade (-0.7%), manufacturing (-0.6%), transport (-0.4%) and utilities (-0.3%). As a consequence of severe drought conditions, output in the agriculture sector has contracted by 6.1% over the past year. Meanwhile, the downturn in the residential construction cycle and the unwind from completing projects in the resources sector has driven a 3.3% fall in output from the construction sector from a year earlier. Also of note, production in manufacturing declined by 2.7% over the year to be broadly reflective of weakness in the sector globally in response to trade and geopolitical tensions.

The health sector continues to lead output in the domestic economy, rising by a further 2.6% in Q3 to be 8.3% higher over the year. This reflects robust growth in public spending to fund aged care services and the NDIS. Output from the mining sector has expanded notably over the past couple of years, with a ramp-up in LNG production key to its strength more recently. The industry-by-industry breakdown for Q3 and over the past year is shown in the chart, below.   

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GDP — Q3 | Prices

Economy-wide inflation as measured by the GDP deflator lifted by 0.7% in Q3, which saw annual growth pare back slightly from 3.8% to 3.7%. However, growth has accelerated since reaching its most recent trough of 0.8% in Q1 2018 and reflects the escalation in the terms of trade over this period. The Gross National Expenditure deflator abstracts for this impact and continues to show modest growth at 0.5% in the quarter and 1.7% over the year. 

On a headline basis, the Consumer Price Index (CPI) lifted by 0.5% in Q3, while the annual pace firmed from 1.6% to 1.7%. Within the National Accounts, the household consumption deflator is a close proxy, though it is based on dynamic consumer spending rather than the 'fixed basket' methodology in the CPI, with this measure rising by 0.5% in the quarter and annual growth lifting from 1.9% to a 5-year high at 2.0%.   

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GDP — Q3 | Productivity

Weakness persists in national productivity and has been a structural headwind for wages growth over recent years. Growth in total hours worked lifted by 0.7% in the quarter, and as this was faster than the rate of output growth at 0.4%, GDP per hour worked contracted by 0.2% in Q3. A similar dynamic is evident over the past year; growth in hours worked is up by 2.0% compared to output growth at 1.7%, thus GDP per hour worked has contracted by 0.2% over the period.

Looking at the market sector (excludes the public sector), hours worked lifted by 0.3% in the quarter to be up by 1.5% through the year. However, this was faster than the pace of output growth recorded by the sector and as a result, GDP per hour worked fell by 0.1% in Q3 and was down by 0.2% on a year earlier, though it is at least on an improving trajectory. Real GDP per capita was flat in Q3 following modest gains of 0.1% and 0.3% in the previous two quarters. Annual growth was 0.2% and maintained its subdued pace of recent times.

In response to weakness in productivity, nominal non-farm unit labour costs increased by 0.6% in Q3 and while annual growth slowed from 3.4% to 3.0%, this pace is around its highest in 8 years. In real terms, non-farm unit labour costs were flat in the quarter and down by 0.9% over the year. Overall, the inflationary pulse is likely to remain soft in line with an elevated level of spare capacity in the labour market.   

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GDP — Q3 | States

In New South Wales, demand lifted by 0.3% in Q3 improving from a soft 0.1% in the previous quarter, though annual growth slowed from 1.5% to 0.6% — its weakest pace since Q2 2013 — and is down sharply from a 3.6% pace a year ago. Driving the slowdown has been household consumption, which lifted by 0.2% in Q3 as the annual pace softened to 0.8% to be at its weakest since the GFC impacted by earlier weakness in the established property market as prices corrected. Residential construction is in its sharpest downturn in 18 years with activity having fallen by around 17% over the past year reflecting weakness in approvals. Business investment lifted only modestly in annual terms (0.8%), with strength coming from non-residential construction and engineering work supported by rising public demand. 

State demand in Victoria increased by 0.4% in the quarter as growth over the year eased from 1.9% to 1.8% to be down from a 4.8% pace a year ago. Over this period, annual growth in household consumption has slowed from 3.5% to 1.3% — its slowest pace in 6 years. Though not as severe as in New South Wales, residential construction is in a downturn with activity having contracted by 2.7% over the past year. Helping to offset to this weakness has been business investment, which lifted by 4.6% in annual terms, as well as robust growth in public spending at 5.3% year-on-year. 

Turning to the other states, demand in Queensland lifted by 0.1% in the quarter and by 1.3% over the year. Household consumption growth remains subdued, while the residential construction cycle and business investment are in a sharp downturn. In South Australia, demand contracted by 0.3% in Q3 to be up by just 0.2% over the year. The weakness is being driven by subdued growth in household consumption and declining construction activity in both the residential and commercial sectors, though some offset is coming from public demand. Demand in Western Australia fell by 0.2% in the quarter and was flat over the past year. Household consumption is stronger than these figures imply at 0.1%q/q and 1.4%Y/Y, though business investment remains the clear point of weakness having contracted by 5.8% over the year as major projects in the mining sector reached completion. Tasmania led demand growth in Q3 at 0.8% and 3.3% through the year. Driving demand growth over the past year has been business investment and public demand. 

Australia's trade surplus steps down to $4.5bn in October

Australia's trade surplus stepped down by $2.3bn in October to a lower-than-expected $4.5bn reflecting declines in iron ore prices from their mid-year peak. As a result, export earnings contracted sharply in the month, while import spending lifted modestly.   

International Trade — October | By the numbers

• The nation's trade surplus stepped down by $2.345bn in October to $4.502bn in October; well below the median forecast for a $6.5bn surplus, and was the lowest monthly surplus since December 2018. September's trade surplus was revised down by the ABS in this report to $6.847bn from $7.18bn.
• Export earnings fell by 5.1% in October (-$2.205bn) to $40.750bn (prior +2.8%m/m), with annual growth pulling back from 14.6% to 6.0%
• Import spending lifted by 0.4% in the month (+$140m) to $36.248bn (prior +2.6%m/m), though annual growth slowed from 3.3% to 1.6%.

International Trade — October | The details 

Export earnings were down by 5.1% in October; their steepest monthly fall since April 2017, representing a hit of $2.2bn compared with the previous month, while annual growth was cut from 14.6% to 6.0% to be at its slowest pace since March of last year. This decline was led by non-rural goods (-6.2%m/m, +1.6%yr) reflecting an 11% fall from metal ores and minerals (mainly iron ore) on weaker prices, as coal (-5%) and other mineral fuels (LNG) (-6%) also fell in the month. Volatile non-montary gold fell by 24.7% in October to largely reverse an increase in the previous month. Rural goods saw a second consecutive monthly rise, with a 2.8% lift in October resulting in annual growth jumping from -1.2% to 10.0%. This appears likely to be driven by higher meat and cereal prices due to drought. Service exports firmed by 0.5% in October to be up by a robust 8.2% on a year earlier. 

Import spending lifted modestly by 0.4% in the month, or by $140m, though annual growth halved from 3.3% to 1.6% on a base effect. Leading the way was consumption goods with a 3.8% rise and is now up by 6.7% year-on-year as the impact of a weaker Australian dollar plays through. Intermediate goods also lifted by 2.3% in October but are down by 3.3% over the year. Capital goods contracted by 2.3% in the month and have softened by 0.6% in annual terms in line with weakness in business investment. Services declined by 0.5% in October, which slowed annual growth from 4.7% to 3.2%.        

     

International Trade — October | Insights 

The narrowing in the nation's monthly trade surplus from $6.8bn to $4.5bn in October comes due mainly to a moderation in iron ore prices from their mid-year peak. However, prices remain relatively high by historical standards and will likely continue to support national income growth. In addition, the services sector is performing strongly and is helped by a lower Australian dollar. Meanwhile, annual growth in imports remains soft in response to weak domestic demand conditions.   

Australian retail sales stall in October

Australian retail spending stalled in October in a soft start to the 4th quarter. In yesterday's National Accounts for Q3, household consumption lifted by just 0.1% in the quarter as annual growth slowed to a post-GFC low at 1.2% amid further weakness in discretionary spending as early indications were that consumers largely saved the windfall from recent RBA rate cuts and tax relief.  

Retail Sales — October | By the numbers

• National turnover was flat in the month on a seasonally adjusted basis at $A27.572bn; short of an anticipated rise of 0.3% and down on a 0.2% increase in September.

• Annual growth in turnover slowed from 2.5% to 2.1% to be at it softest pace in 2 years.
• In trend terms, turnover lifted by 0.2% in the month, with annual growth holding at 2.3%. 

Retail Sales — October | The details 

Retail turnover was little changed in October, declining by $9.0m (-0.03%) to $27.572bn, which followed increases of 0.4% in August and 0.2% in September. Annual growth in turnover has slowed to a 2-year low at 2.1%. Across the categories the detail was soft; food retailing lifted by 0.2% in the month (3.1%yr), though if this category (around 40% of total turnover) is excluded, sales ex-food fell by 0.2% in October (1.4%yr). Within this the outturns were; household goods 0.2%m/m (0.4%yr), clothing and footwear 0.2% (3.1%yr), department stores -0.1% (0.7%yr), 'other' 0.2% (3.0%yr) and cafes, restaurants and takeaway food 0.1% (1.8%yr). 

Across the states, spending declined in New South Wales in October by 0.2% (1.5%yr) and fell by 0.4% in Victoria (1.3%yr). Together, these states account for around 60% of national turnover and if combined, annual growth has slowed to its weakest pace in more than 6 years at 1.4%. 

In the other states, spending contracted by 0.5% in South Australia in October (0.8%yr), though increases were record in Queensland at 0.4% (3.7%yr), Western Australia 0.2% (3.0%yr), and Tasmania 1.4% (4.3%yr). As such, Tasmania takes over 1st place from Queensland in terms of the fastest pace of annual turnover growth in the nation — a title the sunshine state has held since March of this year.  

Meanwhile, online retail spending lifted by a healthy 8.5% in October to $1.930bn according to the ABS's estimates to be up by 13.9% over the year. At 6.5% of total retail turnover, the online segment seems poised to rise to a record high next month on the back of Black Friday sales promotions. 

Retail Sales — October | Insights

This was a disappointing update in light of the weakness in consumer spending highlighted in yesterday's National Accounts for the September quarter. Consumers are clearly cautious, with sentiment at pessimistic levels in the Westpac Melbourne Institute's monthly survey, and have focused on saving and paying down debt rather than spending the windfall from recent stimulus. 

Australian Q3 GDP 0.4%q/q; 1.7%Y/Y

The Australian economy expanded by a softer-than-expected 0.4% in the September quarter missing the median forecast for 0.5%, though annual growth lifted an above consensus to 1.7% (expected 1.6%) after revisions saw the pace in Q2 revised up from 1.4% to 1.6%. The nation's trend rate of growth is estimated to be around 2.75%. The Reserve Bank of Australia's (RBA) forecast is for annual GDP growth to rise to 2.3% by end 2019, implying that output will need to rise by around 0.7% in the December quarter for this expectation to be met. Today's report, however, will likely provide the Bank with some confidence in its assertion that the domestic economy has reached "a gentle turning point". Based on Q3's National Accounts, GDP growth has lifted to around a 2.1% annualised pace over the past two quarters compared to around a 1.1% annualised pace over the period between Q4 2018 and Q1 2019. 

Key uncertainties attend the outlook for the Australian economy, notably from uncertainty offshore associated with trade and geopolitical tensions, while domestically the headwinds are around ongoing slow income growth weighing on household spending, an intensifying downturn in the residential construction cycle and weakness in business investment. In response, the RBA cut the cash rate on three occasions in 2019 to a record low of 0.75%, while the Federal government announced tax relief targeted at low-and middle-income earners in April's budget. Q3's National Accounts reflect the early response from consumers to two of the RBA's rate cuts and the fiscal stimulus, though subdued confidence prompted by concerns around the economic outlook meant that the focus was on saving and paying down debt rather than spending.

The composition of growth continues to remain imbalanced between a robust public sector (1.7%q/q, 5.2%Y/Y) and weakness in private sector demand (-0.3%q/q, -0.4%Y/Y) that reflects the slowdown in household consumption growth, the residential construction downturn and declining business investment.  

Growth in household consumption edged up by 0.1% in Q3; its softest quarterly outcome since Q4 2008, with the annual pace easing from 1.4% to a new post-GFC low of 1.2%. Highlighting the impact of interest rate cuts and tax relief, household disposable income growth in real terms accelerated by 2.1% in the quarter to be up by 3.1% through the year. Helping to explain why this did not flow through to spending, the household saving ratio surged by 2.1ppt to a 2½-year high at 4.8%, with subdued confidence likely playing a key role here. As such, weakness persisted in discretionary spending, which declined by 0.3% in Q3, highlighted by a notably weak outcome from vehicles (-1.0%q/q), and has stalled over the past year. Non-discretionary spending growth was 0.4% in Q3, while annual growth was maintained at 2.0%. 

Residential construction activity declined for the fourth consecutive quarter with a 1.7% fall in Q3, which saw the rate of contraction in through-the-year terms steepen from -7.8% to -9.6%. The annual result of -9.6% indicates that activity across the sector is contracting at its fastest rate since mid-2012. New home building fell by 2.8% in the quarter to be down by 11.0% from a year earlier; its steepest downturn in 18 years, while renovations lifted by a modest 0.6% in Q3 as the annual decline increased from -4.1% to -7.1%.

Business investment remains weak after falling by 2.0% in Q3 and by -1.7% over the year, with offshore uncertainty and weak domestic demand conditions strong headwinds. Equipment spending fell by a sharp 4.5% in the quarter, while non-dwelling construction declined by 1.6% in Q3 in which the weaknesses centred on engineering work (-5.9%) amid a lift in building activity (+3.0%). The ABS's recent Capital Expenditure survey pointed to a less constructive outlook for investment plans in 2019/20, though the mining sector will support the economy. 

Public demand led activity in Q3, supported by a 0.9% rise in consumption spending that centres on public health initiatives, while investment saw renewed strength after recent softness lifting by 5.4% in the September quarter.  

Net exports added 0.3ppt to GDP growth in Q3, with export volumes up by 0.7% driven by strength in the services sector and in resources. Import volumes declined for a fifth straight quarter with a 0.2% fall in Q3 and continues to reflect the impacts of a lower Australian dollar and weak domestic demand conditions.   

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